What It Is:

The S&P (Standard & Poor's) 500 is a diverse index that comprises over 70% of the total market cap of all stocks traded in the U.S. First developed in 1923, the index initially contained 233 stocks. However, in 1957 it was modified to include a diversified basket of 500 common stocks.

How It Works/Example:

The S&P 500 is not comprised of simply the 500 largest U.S. stocks. Instead, it consists primarily of leading companies from a wide variety of different economic sectors. The index started with 23 identified sectors, but today contains over 100 unique sectors. Most analysts choose to use the S&P as their preferred benchmark index thanks to its diversified sector coverage as well as its market value weighting. Because the index is weighted by market cap, the largest firms have the greatest impact on the S&P's value.

Why It Matters:

The S&P 500 index is probably the most commonly referenced U.S. equity benchmark. Many regard it as the single best way to track the overall performance of the largest and most dominant American companies.

Because of the index's high market cap requirements, the S&P 500 does not provide investors with exposure to some of the smaller, yet in many cases faster growing, companies on the market. A number of different mutual funds track the performance of the S&P 500. However, many investors find that the most convenient and cost-effective way to trade this index is to purchase the S&P SPDRs (symbol SPY). This exchange-traded fund, which is commonly referred to as "spyders" or "spiders," tracks the performance of the S&P 500, sports an extremely low expense ratio, and can easily be bought or sold on the open market just like a regular common stock.